1. Monetary and fiscal policies across Europe
The first such mispricing is a broad investor underappreciation of “inflecting” policy dynamics across major developed market central banks. Over the past 12 years, these central banks bought a cumulative total of around USD 20 trillion in assets (as of 30 April 2022), which acted to suppress market volatility and term premiums. This “buying spree” is now ending and, in fact, going into reverse. 2022 could be the first year in more than a decade when global central banks in aggregate become net sellers of sovereign bonds.
Notably, the European Central Bank (ECB) recently shifted to a decidedly more hawkish monetary policy stance, with policymakers now more determined to confront and hopefully subdue mounting inflation — and this despite fears that the ongoing war in Ukraine could drag Europe into recession, given the region’s reliance on energy imports from Russia. In effect, rather than depressing market volatility as in the past, the ECB and other central banks could actually become a source of volatility through 2022 and beyond.
A related implication of the Russia/Ukraine crisis will likely be larger and more enduring fiscal deficits across Europe, where many nations will seek to finance accelerated timetables to rearmament (read: increased defense spending) and greater energy independence (read: higher household energy costs). That could fundamentally change the euro area, including how we think about German bunds, potentially leading to a long-term move back to pre-eurozone-crisis levels.
Increased lending, rising interest rates, and wider credit spreads should provide tailwinds for European cyclical industries, specifically financials. Additionally, we expect surplus capital investment to drive interest rates even higher, which would impact holders of European duration.